I am a senior editor at Forbes, covering legal affairs, corporate finance, macroeconomics and the occasional sailing story. I was the Southwest Bureau manager for Forbes in Houston from 1999 to 2003, when I returned home to Connecticut for a Knight fellowship at Yale Law School. Before that I worked for Bloomberg Business News in Houston and the late, great Dallas Times Herald and Houston Post. While I am a Chartered Financial Analyst and have a year of law school under my belt, most of what I know about financial journalism, I learned in Texas.

Court Decision Gives Lenders A Headache, Borrowers An Ace In The Hole

A recent decision by the Third Circuit Court of Appeals gives borrowers an indefinite period to rescind their home-equity loans, complicating life for lenders and setting up a conflict that may have to be resolved at the Supreme Court.

Home buyers normally have three days to rescind a loan, and after that mortgages to purchase a property can’t be reversed. But federal law allows other types of loans to be rescinded for up to three years if the borrower can prove violations of the Truth in Lending Act, such as an inaccurate interest rate or undisclosed finance charges. If they prevail — and have enough cash to repay the loan principal — borrowers can get a refund of their interest and fees. Most courts, including the Ninth Circuit Court of Appeals, have held that borrowers who want to do this also must sue the bank within the three-year deadline.

But the Third Circuit, in Sherzer vs. Homestar, ruled that borrowers only have to send a letter of notice to the bank. They can sue whenever they want after that, leaving a potential cloud on the lender’s claim against the property that can only be resolved if the lender gets a declaratory judgment denying the recission. The ruling released Tuesday follows a similar decision by the Fourth Circuit and gives borrowers another tactic for delaying lenders that want to seize the collateral backing their loan.

“If you’re having trouble making payments and worried about foreclosure, you could fire off letter to the lender saying you believe there was a material TILA violation,” said Martin Bryce Jr., a partner with Ballard Spahr in Philadelphia. “Then you get to sit back and hold that in your pocket.”

In this case, Daniel and Geraldine Sherzer borrowed $705,000 in one loan and $171,000 on a second against their home in 2004. The loans were sold to HSBC, and in 2007 the Sherzers’ lawyer wrote HSBC and Homestar alleging TILA violations and seeking to rescind. HSBC rescinded the smaller loan but refused to rescind the larger one, and the Sherzers sued after the three-year deadline.

The Consumer Financial Protection Bureau supported the Scherzers, saying the law only requires borrowers to send notice of recission, with court action later merely a process for determining whether the lender needs to comply. But the American Bankers Association and other lenders opposed that reasoning, saying borrowers need to do more than just send a letter to the lender to reverse a loan. They need to sue, as the Ninth Circuit determined, so the court can decide whether recission is merited. The Supreme Court left the question open in a previous decision, Beach vs. Ocwen, which otherwise rejected the idea that borrowers can bring up allegations of TILA violations after the three-year deadline.

Bryce said the Third Circuit’s decision puts banks in a tough position: Once they receive a letter of recission, they either have to sue the borrower to determine whether the demand is valid, or face the possibility of a cloud on their claim to the collateral later.

“Loans still get bought and sold,” he said, but that process will be more difficult if a loan has an unresolved claim for recission hanging over it.

Most courts, he said, have taken a more practical approach to the question. If a borrower wants to rescind, he also should be prepared to sue and put up the cash to pay off the principal balance. Absent that, Bryce said, the demand for recission is “an exercise in futility.”

Under the reasoning adopted by the Third and Fourth Circuits (based in Philadelphia and Richmond, respectively) borrowers don’t need to worry about whether they have the cash to pay off the loan, however. The smartest course is to fire off a letter demanding recission within three years and keep it on hand in case they get in trouble. Then it becomes a bargaining chip with a lender who’s already facing a certain loss on the loan. The question becomes how much more the lender wants to spend on legal fees to gain clear title to the collateral.

Other borrowers, of course, pay the price. Look for this case, or one like it, to percolate up to the Supreme Court.

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Both sides are nuts. Giving someone a loan, which by default they cannot pay the entire principal of a home in 3 years otherwise they wouldn’t get a 30 year loan, then requiring them to pay in full in 3 years is madness. Could there be a more unbalanced piece of legislation? Further, what if they violate the TILA after 3 years? What does the borrower do, then?

Conversely, expecting to be able to just send a letter and have the lenders by the marbles forever is, again, insane. If someone borrows money and doesn’t pay, they should be responsible for that even if it means losing their home. Maybe they’ll be more responsible, next time. If there are TILA violations, they should be able to take them to court and have those wrongs righted via a free refinancing at the original (intended) loan conditions and appropriate interest refunds as compensation. It shouldn’t be a free pass to free money.

Everyone seems to be so unreasonable in their greed, these days. It won’t end until everyone hits rock bottom and wonders “what are we going to do now?”.

No one is asking borrowers to repay in three years, unless they want to rescind the loan. And TILA applies to the initial loan documents, so it would be difficult to violate it more than three years after signing.

There are many cases in which financial crimes against the borrower were kept hidden and were later exposed in various ways. These things are outside of the borrowers AWARENESS and therefore were not part of the decision to take out the mortgage.

The three-year statute of repose gives the borrower time to learn about and investigate things like this and then to have recourse to do something about it. It is after the passage of some time that many of these errors come to light in a transaction.

Remember: A borrower cannot rescind a LEGAL, compliant mortgage!! Rescission is offered as a remedy for fraudulent activity, not as a means to unjust enrichment. There MUST BE material errors in the docs for a borrower to rescind the mortgage.

So let’s say there were TILA violations in the paperwork. What’s the solution? Does the borrower get to keep the collateral and not pay back the loan? If not, does the borrower care so much about those TILA violations? Does the borrower still welcome being sued by the bank? I’d suggest any borrower who wants to rescind a mortgage also should demonstrate the ability to pay it off, otherwise there are other motivations for the action.

In most courts across the nation, the ability to TENDER the mortgage (or repay the entire amount of the debt) is considered if the rescission is contested by the bank. In the 9th cir. Yamamoto v. Bank of NY Mellon set a precedent that the ability to tender can actually usurp the right of rescission, and a bank can actually squelch a rescission action JUST based on that in the 9th Cir. Court.

Danger of rescission was intended to be a deterrent to banks against engaging in deception or fraudulent behavior. The punishment to them for doing so, is they LOSE their compensation (which is all interest and fees charged in connection with the mortgage) and that is more than fair.

The BORROWER must repay all money lent to them in connection with the mortgage AFTER the bank has completed steps 2 and 3 of rescission, which is to release the lien on the property and to repay all money received that was not principle. This is intended to allow the borrower to gain access to a NEW mortgage to repay the prior, defective one back. They cannot do that while there is an existing lien.

When a bank deceives a borrower, they harm not only the borrower, but as we all know, they harm the Nation as a whole. There should be STRONG deterrent from intentional deception and theft in mortgage lending. When you take a punishment, crime thrives. Rescission WAS that deterrent. In the 9th cir, it no longer is.

I just lost my case in the 9th cir, for this exact case scenario, but in reverse. Banks losing the interest they collected (which IS their compensation) is a just punishment for the crime of stealing from a borrower. It’s only a maximum of three years of interest, not the WHOLE THING.

In my case, I discovered 2.5 yrs after closing that my mortgage broker had pocketed about $20K that was “under the table” and taken out of my loan proceeds in a very secretive, undisclosed manner. Long story short, after trying ALL options at resolution and meeting with disdain from said broker, I lawfully rescinded the mortgage 2 years and 11.5 months after closing as a last resort. By waiting the required 20 days for the bank to respond (which they didn’t) I then was barred from rescission because I didn’t SUE them for not responding ***within 3 years***.

Yes, it really is that ridiculous. I could write a book about it, $50,000 in costs later to “defend” my rescission. There are simply stories and circumstances that don’t make it to the main stream media. I am now losing my house of 20 years, and beyond shattered.

There are two clear-cut examples of fraud I am seeing over and over: Mortgage brokers who ripped off their clients and the lender, and borrowers who signed clearly fraudulent applications. Maybe the broker talked them into it, but that doesn’t make it less of a felony.

Yes, very much so: People don’t talk about the brokers like they should. Many DID (and CONTINUE to!!) rip-off BOTH the borrowers, AND the lenders (by submitting false docs, playing poker with the amounts disclosed on the HUD1 docs and by just plain being corrupt.)

I am NOT against foreclosure, quite the contrary. If a borrower isn’t fulfilling their obligation, throw their stuff out on the lawn. We need foreclosure. Some people just want everything for free.

But there truly ARE victims out there too. You have to wade through a sea of scamming borrowers screaming for free houses to see them, but that’s what the mainstream likes to portray: it sells. There are terrible atrocities being committed against American homeowners who are paying their bills and playing by the rules, and are having the rules and amounts owed secretly jimmied by fraudulent entities. Not all banks are corrupt. Not all foreclosed homeowners are deadbeats. That’s all there is to it.

My broker actually laughed at me when I threatened to rescind the mortgage when he wouldn’t simply repair the loan. He told me he didn’t care, because it was the bank that would suffer the rescission, not him. He’s right. He’s probably cruising the Caribbean right now in one of his boats. Meanwhile, we are about to be homeless, and the investor on our mortgage just had to fork out a LOT of litigation money to retain their foreclosure action against us. We both lose.

I wanted to address your comment about the borrower keeping the unsecured collateral of the house after the bank releases the security on it. This is a favorite rant of the banks against the rescission remedy, but upon examination, holds no water.

IF they borrower did fail to repay the loan after the bank released their security interest, then YES, they would have a house for free (with no lien) and could then, in theory, discharge the unsecured debt to the fraudulent lender in bankruptcy.

Any bankruptcy lawyer, even a bad one, would immediately point out that no bankruptcy trustee is going to grant a borrower a discharge of debt when they have an unencumbered asset in their possession. They would seize the house immediately and sell it to satisfy the bankruptcy estate. That would never be allowed to fall through the cracks.

If the borrower simply walked, then the lender could either: A. File a lawsuit to recoup the damage and likely gain access to the equity in the house (happens all the time). B. File a lawsuit and gain a judgement, garnish wages, seize assets, etc.

This is just a non-issue. Yes, it would take a little while, but they would get their money.